Emerging Markets

With the broader dollar appreciation trend losing steam in last several weeks, the fall in oil prices has become the main external variable determining EM performance. Russia, of course, is the weakest link amongst the major EM countries, but Malaysia and Colombia are also coming under pressure. Even Mexico, which has hedged much of its near-term exposure to oil prices, is looking materially more fragile as investors consider that cheaper energy is here to stay.

The huge reversal last week in the underperforming currencies (BRL and RUB) has put some of the bears on the defensive. In addition, the recent political news (except for Mexico) has been positive: Indonesia's increase in subsidized fuel prices was followed by similar action in Malaysia; Brazil’s financial team looks solid (on paper at least); and the surprise interest rate cut by China sends an important signal of support for EM and commodities.

There were few notable developments out of the G20 meeting that would directly impact EM markets. However, the escalating tensions with Russia made evident in the meeting have increased to the point that it could again lead to spillover effects. Separately, the political climate in Brazil is heating up again and starting to feel like a “3rd round” in the electoral dispute. President Dilma is coming under huge pressure to appoint a finance minister, while the corruption scandal surrounding Petrobras deepens further.

Emerging market assets, in general, are lacking a defined direction. The fall in commodity prices seems to be stabilizing, for now at least, but the impact of the large level shift is still to be felt globally. Meanwhile, the dollar appears to be consolidating, which will reduce the pressure on EM assets. We do think the dollar uptrend remains intact, and should continue to hurt EM in the coming weeks. Asian countries, especially Korea, are still adjusting to the rapid depreciation of the yen, and if it continues, there will be action for sure.

Overall, the investment climate for EM is likely to remain negative in this strong dollar environment. A weaker than expected official China PMI over the weekend didn't help matters. Indeed, most of the Asian PMI readings out already came in weaker than expected, with Korea and Indonesia coming in below 50. Expect further deterioration in EM sentiment ahead.